Small business owners have several options for maximizing their retirement savings, taking advantage of retirement savings tax breaks, and helping out their employees. But saving for retirement comes with several rules. Break one, and you could wind up with less income in retirement than you need.

Retirement Rules for Small Business Owners

The average American believes they need $1.9 million in savings for retirement, but their actual savings are much lower — averaging just $255,200.

For many small business owners, the business is their retirement plan. In fact, 34% of small business owners don’t have a retirement savings plan for themselves. When asked why,

  • 34% said they don’t earn enough profit from the business to save for retirement
  • 21% invested their retirement savings in the business
  • 18% plan to sell the business to fund their retirement
  • 12% don’t see a need to save for retirement
  • 12% don’t plan on retiring at all

Failing to prioritize retirement savings can be a costly mistake. Being financially secure in retirement doesn’t just happen. It takes planning and a commitment to saving. 

Plus, setting up a retirement plan for your employees is simply good business. By helping them save for retirement, you can take advantage of tax breaks and improve your chances of attracting and retaining talented employees.

Here are a few rules to keep in mind.

1. Get Professional Help

As a small business owner, you carry the weight of your and your employees’ retirement planning. 

For your own retirement, you have several savings options to choose from — each with its own pros and cons. Talk through your options with a financial advisor to make sure you’re picking the best strategy for your situation.  

  • Individual 401(k): An individual 401(k) can be a good choice for self-employed people without employees. They’re typically low-cost and allow small business owners to make substantial contributions — up to $58,000 in 2021.
  • SEP-IRA: A SEP-IRA provides self-employed people or small business owners with employees a relatively easy way to save for their own retirement and contribute toward their employees’ retirement. In 2021, the business owner can contribute 25% of compensation or $58,000, whichever is less.
  • SIMPLE IRA: Small business owners with less than 100 employees may also set up a SIMPLE IRA. The business owner and employees can contribute up to $13,500 to their own accounts in 2021. However, employers must generally match employee salary reductions up to 3% of annual compensation.
  • Defined Benefit Plan: For business owners age 50 or older, a Defined Benefit Plan allows for larger contributions, and the ability to quickly increase retirement plan assets. However, these plans are the most complicated and expensive to administer because contributions are based on actuarial computations, and the plan must file a tax return each year.

Offering retirement benefits to your employees can get complicated. Depending on the type of plan you choose, you may have to deal with rules about eligibility, contribution limits, vesting, participant notifications, and employer matching. If you withhold employee contributions to the plan, there are rules about how quickly you must deposit them into employee accounts.

To avoid running afoul of the IRS or U.S. Department of Labor (DOL) rules, it’s a good idea to work with a certified public accountant (CPA) or financial advisor who can help you navigate the complicated retirement plan rules. 

2. Diversify Your Investments

When saving for retirement, it’s important not to put all your eggs in one basket. Spreading your savings across different types of accounts and different categories of investments (such as stocks, bonds, and short-term investments) can help limit your losses during economic downturns and stabilize your investment returns in the long run, especially if you follow industry best practices.

3. Don’t Bank on Your Business for Your Retirement Savings

Many small business owners intend to sell the business to fund their retirement. But that’s not as sound a strategy as it seems.

Business owners tend to have an unrealistic idea of what their business is worth and what it takes to sell it. According to a UBS survey, 58% of small business owners have never had their business appraised. 

You may not be able to get enough money from the sale to fund decades of retirement, so it’s important to contribute to your retirement as well as investing in the business.

4. Take Advantage of Tax Breaks

Setting up a retirement plan and contributing to your employee’s accounts can be costly. Fortunately, the IRS offers several incentives for small business owners willing to invest in their employees’ retirement. Here’s a brief overview of available tax breaks:

  • Retirement plans startup costs tax credit: Small business owners can claim a tax credit of up to $5,000 for three years to offset the cost of starting and maintaining a SEP, SIMPLE IRA or 401(k) plan. If you add an auto-enrollment feature to that plan, you can claim an additional tax credit of $500 per year for three years.
  • Employer contributions are tax-deductible: Employer contributions to a retirement plan are deductible on your federal (and possibly state) income tax return. That means you can subtract the amount contributed from your company’s taxable income. Administrative fees are also tax-deductible

5. Educate Your Employees and Yourself 

Setting up a workplace retirement plan is one hurdle. Getting employees to take part in the plan is another. If your employees don’t take advantage of the benefits offered, you waste money offering a benefit they don’t value, and your employees are less prepared for retirement.

That’s why it’s important to help employees understand the fundamentals of their employer-sponsored retirement plan. When offering plan information to employees, make sure they understand what type of plan you offer, how it works, and what features it offers, such as an employer match, the ability to borrow from their account, roll funds from a former employer’s plan, etc.

Your HR team or plan administrator can help with these education efforts. If that’s not an option, the DOL has several resources to help employers communicate plan information to employees.

Saving for your retirement and offering retirement benefits to employees might seem overwhelming or cost-prohibitive. However, it can help secure your own retirement, and employees highly value it. It’s well worth overcoming the initial setup hurdles to ensure you and your employees make healthy investments in your financial future.

About the Author(s)

 Ting  Pen

Ting Pen is a ValuePenguin Co-Founder. She previously evaluated corporate mergers and acquisitions as a Financial Analyst at Citigroup. Her experience in financial services combined with her entrepreneurial spirit allowed for her to start her own fin-tech company. Her passions lie in problem solving, growth, and travel.

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